HEALTHEQUITY, INC. 10-Q

Item 1. Financial statements HealthEquity, Inc. and subsidiaries Condensed consolidated balance sheets (in thousands, except par value) July 31, 2021 January 31, 2021 (unaudited) Assets Current assets Cash and cash equivalents $ 753,754 $ 328,803 Accounts receivable, net of allowance for doubtful accounts of $ 5,824 and $ 4,239 as of July 31, 2021 and January 31, 2021, respectively 74,223 72,767 Other current assets 32,637 58,607 Total current assets 860,614 460,177 Property and equipment, net 27,382 29,106 Operating lease right-of-use assets 83,768 89,508 Intangible assets, net 770,329 767,003 Goodwill 1,363,568 1,327,193 Other assets 42,973 37,420 Total assets $ 3,148,634 $ 2,710,407 Liabilities and stockholders’ equity Current liabilities Accounts payable $ 4,696 $ 1,614 Accrued compensation 40,154 50,670 Accrued liabilities 49,098 75,880 Current portion of long-term debt 78,125 62,500 Operating lease liabilities 13,051 14,037 Total current liabilities 185,124 204,701 Long-term liabilities Long-term debt, net of issuance costs 895,449 924,217 Operating lease liabilities, non-current 69,998 74,224 Other long-term liabilities 20,091 8,808 Deferred tax liability 115,306 119,729 Total long-term liabilities 1,100,844 1,126,978 Total liabilities 1,285,968 1,331,679 Commitments and contingencies (see Note 6) Stockholders’ equity Preferred stock, $ 0.0001 par value, 100,000 shares authorized, no shares issued and outstanding as of July 31, 2021 and January 31, 2021, respectively — — Common stock, $ 0.0001 par value, 900,000 shares authorized, 83,608 and 77,168 shares issued and outstanding as of July 31, 2021 and January 31, 2021, respectively 8 8 Additional paid-in capital 1,648,743 1,158,372 Accumulated earnings 213,915 220,348 Total stockholders’ equity 1,862,666 1,378,728 Total liabilities and stockholders’ equity $ 3,148,634 $ 2,710,407 See accompanying notes to condensed consolidated financial statements. -3- HealthEquity, Inc. and subsidiaries Condensed consolidated statements of operations and comprehensive income (loss) (unaudited) Three months ended July 31, Six months ended July 31, (in thousands, except per share data) 2021 2020 2021 2020 Revenue Service revenue $ 109,182 $ 103,805 $ 211,716 $ 215,076 Custodial revenue 48,776 46,909 95,754 93,808 Interchange revenue 31,145 25,325 65,835 57,166 Total revenue 189,103 176,039 373,305 366,050 Cost of revenue Service costs 67,334 65,246 137,966 136,259 Custodial costs 4,824 4,998 9,833 10,043 Interchange costs 4,974 4,011 10,419 9,890 Total cost of revenue 77,132 74,255 158,218 156,192 Gross profit 111,971 101,784 215,087 209,858 Operating expenses Sales and marketing 15,476 12,167 29,562 23,622 Technology and development 37,898 30,654 73,367 61,732 General and administrative 22,812 20,493 43,499 39,491 Amortization of acquired intangible assets 20,289 19,077 40,103 37,779 Merger integration 16,371 10,365 25,178 23,135 Total operating expenses 112,846 92,756 211,709 185,759 Income (loss) from operations ( 875 ) 9,028 3,378 24,099 Other expense Interest expense ( 7,254 ) ( 8,895 ) ( 13,943 ) ( 21,158 ) Other income (expense), net 344 ( 824 ) ( 3,286 ) ( 1,588 ) Total other expense ( 6,910 ) ( 9,719 ) ( 17,229 ) ( 22,746 ) Income (loss) before income taxes ( 7,785 ) ( 691 ) ( 13,851 ) 1,353 Income tax benefit ( 3,967 ) ( 543 ) ( 7,418 ) ( 325 ) Net income (loss) and comprehensive income (loss) $ ( 3,818 ) $ ( 148 ) $ ( 6,433 ) $ 1,678 Net income (loss) per share: Basic $ ( 0.05 ) $ 0.00 $ ( 0.08 ) $ 0.02 Diluted $ ( 0.05 ) $ 0.00 $ ( 0.08 ) $ 0.02 Weighted-average number of shares used in computing net income (loss) per share: Basic 83,481 72,343 82,628 71,669 Diluted 83,481 72,343 82,628 72,971 See accompanying notes to condensed consolidated financial statements. -4- HealthEquity, Inc. and subsidiaries Condensed consolidated statements of stockholders’ equity (unaudited) Three months ended July 31, Six months ended July 31, (in thousands) 2021 2020 2021 2020 Total stockholders' equity, beginning balance $ 1,848,270 $ 1,040,650 $ 1,378,728 $ 1,030,295 Common stock: Beginning balance 8 7 8 7 Issuance of common stock upon exercise of stock options, and for restricted stock — — — — Other issuance of common stock — 1 — 1 Ending balance 8 8 8 8 Additional paid-in capital: Beginning balance 1,630,529 827,303 1,158,372 818,774 Issuance of common stock upon exercise of stock options, and for restricted stock 2,599 1,618 5,315 2,751 Other issuance of common stock ( 2 ) 286,777 456,640 286,777 Stock-based compensation 15,617 11,438 28,416 18,834 Ending balance 1,648,743 1,127,136 1,648,743 1,127,136 Accumulated earnings Beginning balance 217,733 213,340 220,348 211,514 Net income (loss) ( 3,818 ) ( 148 ) ( 6,433 ) 1,678 Ending balance 213,915 213,192 213,915 213,192 Total stockholders' equity, ending balance $ 1,862,666 $ 1,340,336 $ 1,862,666 $ 1,340,336 See accompanying notes to condensed consolidated financial statements. -5- HealthEquity, Inc. and subsidiaries Condensed consolidated statements of cash flows (unaudited) Six months ended July 31, (in thousands) 2021 2020 Cash flows from operating activities: Net income (loss) $ ( 6,433 ) $ 1,678 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 64,819 56,106 Stock-based compensation 28,416 18,834 Amortization of debt issuance costs 2,482 2,533 Change in fair value of contingent consideration 1,011 — Other non-cash items ( 752 ) 1,145 Deferred taxes ( 4,051 ) ( 568 ) Changes in operating assets and liabilities: Accounts receivable, net ( 230 ) 628 Other assets 20,636 ( 3,187 ) Operating lease right-of-use assets 6,060 5,563 Accrued compensation ( 10,639 ) ( 13,854 ) Accounts payable, accrued liabilities, and other current liabilities ( 30,213 ) 30 Operating lease liabilities, non-current ( 4,556 ) ( 5,723 ) Other long-term liabilities 1,616 5,477 Net cash provided by operating activities 68,166 68,662 Cash flows from investing activities: Acquisitions, net of cash acquired ( 49,533 ) — Purchases of software and capitalized software development costs ( 32,097 ) ( 21,787 ) Purchases of property and equipment ( 6,352 ) ( 8,987 ) Acquisition of intangible member assets ( 2,653 ) ( 24,922 ) Proceeds from sale of equity securities 2,367 — Net cash used in investing activities ( 88,268 ) ( 55,696 ) Cash flows from financing activities: Proceeds from follow-on equity offering, net of payments for offering costs 456,642 287,318 Principal payments on long-term debt ( 15,625 ) ( 215,625 ) Settlement of client-held funds obligation, net ( 2,636 ) ( 10,292 ) Proceeds from exercise of common stock options 6,672 2,817 Net cash provided by financing activities 445,053 64,218 Increase in cash and cash equivalents 424,951 77,184 Beginning cash and cash equivalents 328,803 191,726 Ending cash and cash equivalents $ 753,754 $ 268,910 See accompanying notes to condensed consolidated financial statements. -6- HealthEquity, Inc. and subsidiaries Condensed consolidated statements of cash flows (unaudited) (continued) Six months ended July 31, (in thousands) 2021 2020 Supplemental cash flow data: Interest expense paid in cash $ 9,838 $ 17,659 Income tax payments (refunds), net ( 5,545 ) 798 Supplemental disclosures of non-cash investing and financing activities: Purchases of software and capitalized software development costs included in accounts payable, accrued liabilities, or accrued compensation 4,077 1,262 Purchases of property and equipment included in accounts payable or accrued liabilities 357 1,104 Contingent consideration recognized at acquisition 8,147 — Exercise of common stock options receivable 119 66 Purchases of intangible member assets — 58 Additions to goodwill due to measurement period adjustments — 1,177 Follow-on equity offering costs accrued during the period — 540 See accompanying notes to condensed consolidated financial statements. -7- Table of Contents HealthEquity, Inc. and subsidiaries Notes to condensed consolidated financial statements Note 1. Summary of business and significant accounting policies Business HealthEquity, Inc. ("HealthEquity" or the "Company") was incorporated in the state of Delaware on September 18, 2002. HealthEquity is a leader in administering health savings accounts (“HSAs”) and complementary consumer-directed benefits (“CDBs”), which empower consumers to access tax-advantaged healthcare savings while also providing corporate tax advantages for employers. Principles of consolidation The condensed consolidated financial statements include the accounts of HealthEquity and its direct and indirect subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Basis of presentation The accompanying condensed consolidated financial statements as of July 31, 2021 and for the three and six months ended July 31, 2021 and 2020 are unaudited and have been prepared in conformity with accounting principles generally accepted in the United States of America ("GAAP") and the applicable rules and regulations of the Securities and Exchange Commission ("SEC") regarding interim financial reporting. In the opinion of management, the interim data includes all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results for the interim periods. Certain information and note disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. Therefore, these condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the Company's Annual Report on Form 10-K for the fiscal year ended January 31, 2021. The fiscal year-end condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP. Certain reclassifications have been made to prior year amounts to conform to the current year presentation. Follow-on equity offering In the first quarter of fiscal year 2022, the Company closed a follow-on public offering of 5,750,000 shares of common stock at a public offering price of $ 80.30 per share, less the underwriters' discount. The Company received net proceeds of $ 456.6 million after deducting underwriting discounts and commissions of $ 4.6 million and other offering expenses of approximately $ 0.5 million. The Company used $ 50.2 million of the net proceeds from the offering to acquire 100 % of the outstanding capital stock of Fort Effect Corp, d/b/a Luum, and intends to use the remaining net proceeds from the offering for general corporate purposes, which may include prepayments under its term loan facility or potential acquisitions, including the acquisitions of Further and the Fifth Third Bank HSA portfolio. Significant accounting policies There have been no material changes in the Company’s significant accounting policies as compared to the significant accounting policies described in the Company’s Annual Report on Form 10-K for the fiscal year ended January 31, 2021. Recently adopted accounting pronouncements None. Recently issued accounting pronouncements not yet adopted None. -8- Table of Contents Note 2. Net income (loss) per share The following table sets forth the computation of basic and diluted net income (loss) per share: Three months ended July 31, Six months ended July 31, (in thousands, except per share data) 2021 2020 2021 2020 Numerator (basic and diluted): Net income (loss) $ ( 3,818 ) $ ( 148 ) $ ( 6,433 ) $ 1,678 Denominator (basic): Weighted-average common shares outstanding 83,481 72,343 82,628 71,669 Denominator (diluted): Weighted-average common shares outstanding 83,481 72,343 82,628 71,669 Weighted-average dilutive effect of stock options and restricted stock units — — — 1,302 Diluted weighted-average common shares outstanding 83,481 72,343 82,628 72,971 Net income (loss) per share: Basic $ ( 0.05 ) $ 0.00 $ ( 0.08 ) $ 0.02 Diluted $ ( 0.05 ) $ 0.00 $ ( 0.08 ) $ 0.02 For the three months ended July 31, 2021 and 2020, 1.9 million and 2.1 million shares, respectively, attributable to stock options and restricted stock units were excluded from the calculation of diluted earnings per share as their inclusion would have been anti-dilutive. For the six months ended July 31, 2021 and 2020, approximately 2.0 million and 0.6 million shares, respectively, attributable to stock options and restricted stock units were excluded from the calculation of diluted earnings per share as their inclusion would have been anti-dilutive. Note 3. Business combination Acquisition of Luum On March 8, 2021, the Company acquired 100 % of the outstanding capital stock of Fort Effect Corp, d/b/a Luum (the "Luum Acquisition"). Luum provides employers with a suite of commute tools as well as real-time commute data to help them design and implement flexible return-to-office and hybrid-workplace strategies and benefits. The aggregate purchase price consisted of $ 50.2 million in cash, and up to $ 20.0 million in additional payments which are contingent on Luum achieving certain revenue targets during the two-year period following the closing of the Luum Acquisition and, if achieved, would be payable in fiscal years 2023 and 2024. The Company recorded an $ 8.1 million liability representing its best estimate of the fair value of the contingent consideration as of the acquisition date. The fair value of this contingent consideration was determined using a Monte Carlo valuation model based on Level 3 inputs and will be remeasured to fair value quarterly, with any changes in the fair value recorded as other income (expense), net, in the condensed consolidated statement of operations and comprehensive income (loss). As of July 31, 2021, the fair value of the contingent consideration liability was $ 9.2 million. The Luum Acquisition was accounted for under the acquisition method of accounting for business combinations. Consideration paid was allocated to the tangible and intangible assets acquired and liabilities assumed based on their fair values as of the acquisition date. The initial allocation of the consideration paid was based on a preliminary valuation and is subject to adjustment during the measurement period (up to one year from the acquisition date). Balances subject to adjustment primarily include the valuations of acquired assets (tangible and intangible) and liabilities assumed, as well as tax-related matters. The Company expects the allocation of the consideration transferred to be finalized within the measurement period. -9- Table of Contents The following table summarizes the Company's current allocation of the consideration paid: (in thousands) Estimated fair value Cash and cash equivalents $ 626 Other current assets 1,469 Intangible assets 23,900 Goodwill 36,374 Other assets 100 Current liabilities ( 597 ) Deferred tax liability ( 3,566 ) Total consideration paid $ 58,306 The Luum Acquisition resulted in $ 36.4 million of goodwill. The preliminary goodwill to be recognized is attributable to several strategic, operational, and financial benefits expected from the Luum Acquisition, including an expanded commuter offering beyond traditional pre-tax commuter benefits and additional cross-selling opportunities. The goodwill created in the Luum Acquisition is not expected to be deductible for tax purposes. The preliminary allocation of consideration exchanged to acquired identified intangible assets is as follows: ($ in thousands) Fair value Estimated life (in years) Customer relationships (1) $ 12,400 7.0 Developed technology (1) 10,900 5.0 Trade names & trademarks (1) 600 3.0 Total acquired intangible assets $ 23,900 6.0 (1) The Company preliminarily valued the acquired assets utilizing the discounted cash flow method, a form of the income approach. The pro forma effects of the Luum Acquisition would not materially impact the Company's reported results for any period presented, and as a result no pro forma financial information is presented. Note 4. Supplemental financial statement information Selected condensed consolidated balance sheet and condensed consolidated statement of operations and comprehensive income (loss) components consisted of the following: Property and equipment Property and equipment consisted of the following as of July 31, 2021 and January 31, 2021: (in thousands) July 31, 2021 January 31, 2021 Leasehold improvements $ 20,604 $ 22,271 Furniture and fixtures 9,014 9,230 Computer equipment 33,927 28,592 Property and equipment, gross 63,545 60,093 Accumulated depreciation ( 36,163 ) ( 30,987 ) Property and equipment, net $ 27,382 $ 29,106 Depreciation expense for the three months ended July 31, 2021 and 2020 was $ 3.5 million and $ 4.1 million, respectively, and $ 7.4 million and $ 8.0 million for the six months ended July 31, 2021 and 2020, respectively. Contract balances The Company does not recognize revenue until its right to consideration is unconditional and therefore has no related contract assets. The Company records a receivable when revenue is recognized prior to payment and the Company has unconditional right to payment. Alternatively, when payment precedes the related services, the Company records a contract liability, or deferred revenue, until its performance obligations are satisfied. As of July 31, 2021 and January 31, 2021, the balance of deferred revenue was $ 4.0 million and $ 4.1 million, respectively. The balances are related to cash received in advance for an interchange revenue arrangement, other up-front fees and other commuter deferred revenue, and are generally recognized within twelve months, with the -10- Table of Contents exception of the interchange arrangement, which is recognized over a term of approximately ten years . During the three and six months ended July 31, 2021, approximately $ 0.5 million and $ 1.1 million of revenue was recognized that was included in the balance of deferred revenue as of January 31, 2021. Leases The components of operating lease costs were as follows: Three months ended July 31, Six months ended July 31, (in thousands) 2021 2020 2021 2020 Operating lease expense $ 3,498 $ 3,925 $ 7,809 $ 8,249 Sublease income ( 450 ) ( 450 ) ( 900 ) ( 900 ) Net operating lease expense $ 3,048 $ 3,475 $ 6,909 $ 7,349 Other income (expense), net Other income (expense), net, consisted of the following: Three months ended July 31, Six months ended July 31, (in thousands) 2021 2020 2021 2020 Interest income $ 533 $ 76 $ 941 $ 676 Acquisition gains (costs), net ( 1,665 ) 28 ( 7,604 ) ( 66 ) Other income (expense), net 1,476 ( 928 ) 3,377 ( 2,198 ) Total other income (expense), net $ 344 $ ( 824 ) $ ( 3,286 ) $ ( 1,588 ) Supplemental cash flow information related to the Company's operating leases was as follows: Six months ended July 31, (in thousands) 2021 2020 Cash paid for amounts included in the measurement of lease liabilities: Operating cash flows from operating leases $ 7,261 $ 6,468 Operating lease right-of-use assets obtained in exchange for new operating lease obligations $ 320 $ 17,480 Note 5. Intangible assets and goodwill Intangible assets The gross carrying amount and associated accumulated amortization of intangible assets were as follows as of July 31, 2021 and January 31, 2021: (in thousands) July 31, 2021 January 31, 2021 Amortizable intangible assets: Software and software development costs $ 161,134 $ 127,005 Acquired HSA portfolios 127,794 125,141 Acquired customer relationships 613,781 601,381 Acquired developed technology 107,825 96,925 Acquired trade names 12,900 12,300 Amortizable intangible assets, gross 1,023,434 962,752 Accumulated amortization ( 253,105 ) ( 195,749 ) Amortizable intangible assets, net $ 770,329 $ 767,003 Amortization expense for the three months ended July 31, 2021 and 2020 was $ 29.5 million and $ 24.5 million, respectively, and $ 57.4 million and $ 48.1 million for the six months ended July 31, 2021 and 2020, respectively. Goodwill During the six months ended July 31, 2021, goodwill increased by $ 36.4 million due to the Luum Acquisition. For further information, see Note 3—Business combination. There were no other changes to the carrying value of goodwill during the six months ended July 31, 2021. -11- Table of Contents Note 6. Commitments and contingencies Commitments Contingent acquisition consideration. In connection with the Luum Acquisition, the Company agreed to pay up to $ 20.0 million in additional payments which are contingent on Luum achieving certain revenue targets during the two-year period following the closing of the Luum Acquisition and, if achieved, would be payable in fiscal years 2023 and 2024. For further information, see Note 3—Business combination. Fifth Third Bank HSA portfolio acquisition. In April 2021, the Company entered into a definitive agreement with Fifth Third Bank, National Association ("Fifth Third"), to transition custodianship of Fifth Third’s HSA portfolio to HealthEquity. The definitive agreement contemplates a $ 60.8 million dollar purchase price for a transfer of approximately 149,000 HSA members and their approximately $ 477.0 million of HSA assets. The agreement includes a mechanism to adjust the purchase price based on the amount of HSA assets actually transferred. The transaction is subject to satisfaction of certain customary closing conditions and is expected to close by the end of the Company's fiscal third quarter. Further acquisition. In April 2021, the Company entered into a definitive agreement to acquire Further for $ 500 million. Further is a leading provider of HSA and other CDB administration services, with approximately 550,000 HSAs and $ 1.7 billion of HSA assets. In September 2021, the terms of the acquisition were amended pursuant to two agreements: (1) an agreement to acquire all cash balances and investment assets included in any voluntary employee beneficiary association (“VEBA”) account that is funding a health reimbursement arrangement (either Section 501(c)(9) or Section 115 trusts) and all contracts related exclusively thereto for, which is anticipated to close on January 31, 2022 for a maximum purchase price of $ 45 million, calculated based on the actual amount of VEBA assets transferred relative to the total amount of VEBA assets as of April 30, 2021, and (2) an amended agreement to acquire the remainder of the Further business for $ 455 million, with a target closing date on November 1, 2021. The transactions are subject to satisfaction of certain customary closing conditions. Lease termination. In April 2021, the Company exercised its right to terminate an operating lease that had not yet commenced with aggregate undiscounted lease payments of $ 63.1 million and a term of approximately 11 years following the landlord's failure to fulfill its obligations under the lease agreement. The Company's right to terminate the lease agreement is disputed by the landlord. Because the lease had not yet commenced, the Company had not recognized a right-of-use asset, operating lease liability, or any rent expense associated with the lease. Other commitments. The Company’s other commitments consist primarily of a term loan facility, operating lease obligations for office space, data storage facilities, and other leases, a processing services agreement with a vendor, and contractual commitments related to network infrastructure, equipment, and certain maintenance agreements under long-term, non-cancelable commitments. Except for the items noted above, there were no material changes during the three and six months ended July 31, 2021, outside of the ordinary course of business, in our commitments from those disclosed in our Annual Report on Form 10-K for the fiscal year ended January 31, 2021. Contingencies As described above, the Company's right to terminate an operating lease agreement with aggregate undiscounted lease payments of $ 63.1 million is disputed by the landlord. In the normal course of business, the Company enters into contracts and agreements that contain a variety of covenants, representations, and warranties and provide for general indemnifications. The Company’s exposure under these agreements is unknown because it involves claims that may be made against the Company in the future, but have not yet been made. The Company accrues a liability for such matters when it is probable that future expenditures will be made and such expenditures can be reasonably estimated. Legal matters On March 9, 2018, a putative class action was filed in the U.S. District Court for the Northern District of California (the “Securities Class Action”). On May 16, 2019, a consolidated amended complaint was filed by the lead plaintiffs asserting claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, against the Company's subsidiary WageWorks, Inc. ("WageWorks"), its former Chief Executive Officer and its former Chief Financial Officer on behalf of purchasers of WageWorks common stock between May 6, 2016 and March 1, 2018. The complaint also alleged claims under the Securities Act of 1933, as amended, arising from WageWorks’ June 19, 2017 common stock offering against those same defendants, as well as the members of its board of directors at the time of that offering. The class action settled for $ 30.0 million. During the quarter ended July 31, 2021, WageWorks -12- Table of Contents contributed $ 5.0 million and its insurers paid the remaining $ 25.0 million. The court granted final approval of the settlement and entered a final judgment on August 20, 2021. On June 22, 2018 and September 6, 2018, two derivative lawsuits were filed against certain of WageWorks’ former officers and directors and WageWorks (as nominal defendant) in the Superior Court of the State of California, County of San Mateo. The actions were consolidated. On July 23, 2018, a similar derivative lawsuit was filed against certain former WageWorks’ officers and directors and WageWorks (as nominal defendant) in the U.S. District Court for the Northern District of California (together, the “Derivative Suits”). The allegations in the Derivative Suits relate to substantially the same facts as those underlying the Securities Class Action described above. The plaintiffs seek unspecified damages, fees and costs. Plaintiffs in the Superior Court action filed an amended consolidated complaint on October 28, 2019, naming as defendants certain former officers and directors of WageWorks and alleging a direct claim of "inseparable fraud/breach of fiduciary duty" on behalf of a class. WageWorks was not named as a party in that complaint. On June 24, 2020, the court granted the defendants’ motion to dismiss the amended complaint. The plaintiffs subsequently filed a notice of appeal. The District Court action is currently stayed. WageWorks previously entered into indemnification agreements with its former directors and officers and, pursuant to these indemnification agreements, is covering the defense fees and costs of its former directors and officers in the legal proceedings described above. The Company and its subsidiaries are involved in various other litigation, governmental proceedings and claims, not described above, that arise in the normal course of business. It is not possible to determine the ultimate outcome or the duration of such litigation, governmental proceedings or claims, or the impact that such litigation, proceedings and claims will have on the Company’s financial position, results of operations, and cash flows. As required under GAAP, the Company records a provision for contingent losses when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Except with respect to the Securities Class Action, which has been settled, the Company does not believe, based on currently available information, that any liabilities relating to these matters are probable or that the amount of any resulting loss is estimable. However, litigation is subject to inherent uncertainties and the Company’s view of these matters may change in the future. Were an unfavorable outcome to occur, there exists the possibility of a material adverse impact on the Company’s financial position, results of operations and cash flows for the period in which the unfavorable outcome occurs, and potentially in future periods. Note 7. Income taxes The Company follows Accounting Standards Codification ("ASC") 740-270, Income Taxes - Interim Reporting , for the computation and presentation of its interim period tax provision. Accordingly, management estimated the effective annual tax rate and applied this rate to the year-to-date pre-tax book income (loss) to determine the interim benefit or provision for income taxes. For the three and six months ended July 31, 2021, the Company recorded an income tax benefit of $ 4.0 million and $ 7.4 million, respectively. This resulted in an effective income tax benefit rate of 50.8 % and 53.6 % for the three and six months ended July 31, 2021, respectively, compared with an effective income tax benefit rate of 78.6 % and 24.0 % for the three and six months ended July 31, 2020, respectively. For the three and six months ended July 31, 2021, discrete tax items had an effective tax rate benefit of 25.6 % and 28.9 %, respectively, compared with an effective tax rate benefit of 62.9 % and 57.4 % for the three and six months ended July 31, 2020, respectively, primarily due to excess tax benefits on stock-based compensation expense recognized in the provision for income taxes. As of July 31, 2021 and January 31, 2021, the Company’s total gross unrecognized tax benefit was $ 10.7 million and $ 10.2 million, respectively. If recognized, $ 9.9 million of the total gross unrecognized tax benefits would affect the Company's effective tax rate as of July 31, 2021. The Company files income tax returns with U.S. federal and state taxing jurisdictions and is currently under examination by the IRS and in the state of Texas. These examinations may lead to ordinary course adjustments or proposed adjustments to our taxes, net operating losses, and/or tax credit carryforwards. As a result of the Company's net operating loss carryforwards and tax credit carryforwards, the Company remains subject to examination by one or more jurisdictions for tax years after 2001. -13- Table of Contents Note 8. Indebtedness Long-term debt consisted of the following: (in thousands) July 31, 2021 January 31, 2021 Term loan facility $ 987,500 $ 1,003,125 Less: unamortized loan issuance costs (1) 13,926 16,408 Long-term debt, net of issuance costs $ 973,574 $ 986,717 (1) In addition to the $ 13.9 million and $ 16.4 million of unamortized issuance costs related to the term loan facility as of July 31, 2021 and January 31, 2021, respectively, $ 4.3 million and $ 5.0 million of unamortized issuance costs related to our revolving credit facility are included within other assets on the condensed consolidated balance sheets as of July 31, 2021 and January 31, 2021, respectively. The Company is party to a credit facility (the "Credit Agreement”) that provides for: (i) a five-year senior secured term loan A facility (the “Term Loan Facility”), in an aggregate principal amount of $ 1.25 billion; and (ii) a five-year senior secured revolving credit facility (the “Revolving Credit Facility” and, together with the Term Loan Facility, the “Credit Facilities”), in an aggregate principal amount of up to $ 350.0 million, which may be used for working capital and general corporate purposes, including acquisitions and other investments. No amounts were drawn under the Revolving Credit Facility as of July 31, 2021. Borrowings under the Credit Facilities bear interest at an annual rate equal to, at the option of HealthEquity, either (i) LIBOR (adjusted for reserves) plus a margin ranging from 1.25 % to 2.25 % or (ii) an alternate base rate plus a margin ranging from 0.25 % to 1.25 %, with the applicable margin determined by reference to a leverage-based pricing grid set forth in the Credit Agreement. As of July 31, 2021, the stated interest rate was 1.84 % and the effective interest rate was 2.37 %. The Company is also required to pay certain fees to the lenders, including, among others, a quarterly commitment fee on the average unused amount of the Revolving Credit Facility at a rate ranging from 0.20 % to 0.40 %, with the applicable rate also determined by reference to a leverage-based pricing grid set forth in the Credit Agreement. The Credit Agreement contains customary affirmative and negative covenants, including covenants that limit, among other things, the ability of the Company to incur additional indebtedness, create liens, merge or dissolve, make investments, dispose of assets, engage in sale and leaseback transactions, make distributions and dividends and prepayments of junior indebtedness, engage in transactions with affiliates, enter into restrictive agreements, amend documentation governing junior indebtedness, modify its fiscal year and modify its organizational documents, in each case, subject to customary exceptions, thresholds, qualifications and “baskets.” In addition, the Credit Agreement contains financial performance covenants, which require the Company to maintain (i) a maximum total net leverage ratio, measured as of the last day of each fiscal quarter, of no greater than 4.50 to 1.00 (subject to a customary “acquisition holiday” provision that allows the maximum total net leverage ratio to increase to 5.00 to 1.00 for the four fiscal quarter period ending on or following the date of a permitted acquisition by the Company in excess of $ 100.0 million), and (ii) a minimum interest coverage ratio, measured as of the last day of each fiscal quarter, of no less than 3.00 to 1.00. The Company was in compliance with all covenants under the Credit Agreement as of July 31, 2021, and for the period then ended. The obligations of HealthEquity under the Credit Agreement are required to be unconditionally guaranteed by WageWorks and Fort Effect Corp and are secured by security interests in substantially all assets of HealthEquity and the guarantors, subject to certain customary exceptions. -14- Table of Contents Note 9. Stock-based compensation The following table shows a summary of stock-based compensation in the Company's condensed consolidated statements of operations and comprehensive income (loss) during the periods presented: Three months ended July 31, Six months ended July 31, (in thousands) 2021 2020 2021 2020 Cost of revenue $ 3,068 $ 2,065 $ 5,471 $ 3,528 Sales and marketing 2,660 1,818 4,848 2,776 Technology and development 3,693 2,493 6,706 5,410 General and administrative 6,196 5,062 11,391 7,120 Other expense (1) — — 342 — Total stock-based compensation expense $ 15,617 $ 11,438 $ 28,758 $ 18,834 (1) Equity-based awards exchanged for cash in connection with the Luum Acquisition. Stock award plans Incentive Plan. The Company grants stock options, restricted stock units ("RSUs"), and restricted stock awards ("RSAs") under the HealthEquity, Inc. 2014 Equity Incentive Plan (as amended and restated, the "Incentive Plan"), which provided for the issuance of stock awards to the directors and team members of the Company to purchase up to an aggregate of 2.6 million shares of common stock. In addition, under the Incentive Plan, the number of shares of common stock reserved for issuance under the Incentive Plan automatically increases on February 1 of each year, beginning as of February 1, 2015 and continuing through and including February 1, 2024, by 3 % of the total number of shares of the Company’s capital stock outstanding on January 31 of the preceding fiscal year, or a lesser number of shares determined by the board of directors. As of July 31, 2021, 7.5 million shares were available for grant under the Incentive Plan. Stock options A summary of stock option activity is as follows: Outstanding stock options (in thousands, except for exercise prices and term) Number of options Range of exercise prices Weighted- average exercise price Weighted- average contractual term (in years) Aggregate intrinsic value Outstanding as of January 31, 2021 1,674 $ 1.25 - 82.39 $ 31.46 5.00 $ 87,164 Exercised ( 225 ) $ 1.25 - 44.53 $ 23.69 Outstanding as of July 31, 2021 1,449 $ 1.25 - 82.39 $ 32.66 4.40 $ 60,083 Vested and expected to vest as of July 31, 2021 1,449 $ 32.66 4.40 $ 60,083 Exercisable as of July 31, 2021 1,352 $ 29.95 4.20 $ 59,645 Restricted stock units and restricted stock awards A summary of RSU and RSA activity is as follows: RSUs and PRSUs RSAs and PRSAs (in thousands, except weighted-average grant date fair value) Shares Weighted-average grant date fair value Shares Weighted-average grant date fair value Outstanding as of January 31, 2021 1,832 $ 60.41 193 $ 61.77 Granted 1,265 72.47 — — Vested ( 383 ) 57.64 ( 116 ) 61.77 Forfeited ( 103 ) 60.43 ( 73 ) 61.77 Outstanding as of July 31, 2021 2,611 $ 66.66 4 $ 61.72 Performance restricted stock units. During the first quarter of fiscal year 2022, the Company awarded 249,750 performance restricted stock units ("PRSUs") subject to a market condition based on the Company’s total shareholder return ("TSR") relative to the Russell 2000 index as measured on January 31, 2024. The Company used a Monte Carlo simulation to determine that the grant date fair value of the awards was $ 22.4 million. -15- Table of Contents Compensation expense is recorded if the service condition is met regardless of whether the market condition is satisfied. The market condition allows for a range of vesting from 0 % to 200 % based on the level of performance achieved. The PRSUs cliff vest upon approval by the Compensation Committee of the board of directors. Note 10. Fair value Fair value measurements are made at a specific point in time based on relevant market information. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Accounting standards specify a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. These two types of inputs have created the following fair value hierarchy: • Level 1—quoted prices in active markets for identical assets or liabilities; • Level 2—inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and • Level 3—unobservable inputs based on the Company’s own assumptions. Level 1 instruments are valued based on publicly available daily net asset values. Level 1 instruments consist primarily of cash and cash equivalents. The carrying value of cash and cash equivalents approximate fair values as of July 31, 2021 due to the short-term nature of these instruments. Our long-term debt is considered a Level 2 instrument and is recorded at book value in our condensed consolidated financial statements. Our long-term debt reprices frequently due to variable interest rate terms and entails no significant changes in credit risk. As a result, we believe the fair value of our long-term debt approximates carrying value. The contingent consideration liability resulting from the Luum Acquisition was determined using a Monte Carlo valuation model based on Level 3 inputs. The estimate of fair value of the contingent consideration obligation requires subjective assumptions to be made regarding revenue growth rates, discount rates, peer revenue volatilities, and probabilities assigned to various potential business result scenarios and was determined using probability assessments with respect to the likelihood of achieving certain revenue targets. The fair value measurement is based on inputs unobservable in the market and thus represents a level 3 measurement. Changes in current expectations of progress could change the probability of achieving the targets within the measurement periods and result in an increase or decrease in the fair value of the contingent consideration obligation. For further information, see Note 3—Business combination. The following table reconciles the change in the fair value of the contingent consideration during the period presented: (in thousands) Carrying Amount Balance as of January 31, 2021 $ — Contingent consideration recognized at acquisition 8,147 Change in fair value recognized in the condensed consolidated statement of operations and comprehensive income (loss) 1,011 Balance as of July 31, 2021 $ 9,158 -16- Tabl e of Co ntents